Summary of the Ruling
The IRS in PLR 201820013 adopted the binding commitment test to determine that a multi-step acquisition constituted “a series of related transactions” for purposes of testing relatedness under the anti-churning rule of Code Section 197(f)(9).
The PLR involved a two-step sale of interests in an LLC where the first sale of interests and the second sale of interests were separated by more than a year. The step one sale of LLC interests converted the LLC from a disregarded entity to a partnership, and thus constituted a deemed sale of assets, including goodwill that was not amortizable under section 197 in the hands of the seller. The step two sale of LLC interests reduced the seller’s interest in the partnership to under 20%. The IRS ruled that the anti-churning rule Baker McKenzie buyer of the LLC interests was deemed to have purchased in the step one sale and, further, that the buyer could begin amortizing such purchased goodwill on the first day of the month of the step one sale.
Section 197 provides 15-year straight line amortization for certain intangible assets acquired after August 10, 1993. Prior to the enactment of section 197, certain intangible assets, such as goodwill, were not amortizable. When it enacted section 197, Congress was concerned that taxpayers might attempt to convert such non-amortizable assets into amortizable ones by structuring an acquisition of the assets where the ultimate user of the intangible assets did not change.
To prevent this, Congress included an anti-abuse rule in section 197(f)(9), known as the anti-churning rule. Section 197(f)(9) prohibits the amortization of any section 197 intangible that would not have been amortizable under prior law if it is acquired after August 10, 1993, by the taxpayer, and the taxpayer or a related person held or used the asset after July 25, 1991, and before August 10, 1993. This means a taxpayer cannot amortize goodwill on a section 197 intangible that either it or a related party held or used before the enactment of section 197.
For purposes of the anti-churning rule, a “related person” includes any person related within the meaning of section 707(b), substituting 20% for 50%. That is, a partnership and any person owning a more than a 20% interest, directly or indirectly, are related. In the case of a series of related transactions, Treas. Reg. § 1.197-2(h) provides that relatedness is tested immediately before the earliest transaction and immediately after the last transaction. Thus, where multiple steps have occurred, it is essential to determine whether transactions are treated as separate or constitute a series of related transactions in order to determine whether the anti-churning rule will apply to prohibit amortization under section 197.
PLR 201820013 involves a disregarded, single member LLC (“C”) wholly owned by an S Corporation (“B”). C in turn owns a number of operating entities that are also disregarded for US federal income tax purposes, the oldest of which was incorporated before the enactment of section 197. B also owns significant goodwill attributable to the business of the oldest of these disregarded operating subsidiaries. That goodwill was not amortizable by B under section 197.
In step one of the purchase transaction, B sold part of its interest in C to a buyer (“Buyer”). Under Rev. Rul. 99-5, situation 1, the sale of the interests in C was deemed to be a taxable sale of the an undivided percentage interest each of the assets of C, including the goodwill, to Buyer, followed by a tax-free contribution by B and Buyer of the assets of C to a partnership. Immediately after the deemed asset purchase, B presumably still held a more than 20% interest in C. Thus, if relatedness were tested immediately after step one, the goodwill would still be held by a related party. Accordingly, because of the anti-churning rule, the goodwill would not be amortizable under section 197.
After the step one purchase, B and Buyer entered into a LLC Agreement. The terms of the LLC Agreement establish a binding commitment for step two of the purchase by Buyer. In step two, Buyer is obligated to purchase more of B’s interest in C. The LLC agreement laid out all the terms of the step two purchase, including the date of the step two purchase on a certain anniversary of the effective date of the LLC agreement. The taxpayer represented that there were no contingencies related to the step two purchase other than the passage of time. After the step two purchase, B would own less than 20% of C. Thus, if step one and step two were treated as part of “a series of related transactions” and relatedness is tested after step two, then the goodwill would not be held by a related party. As a result, the anti-churning rule would not apply and the goodwill would be amortizable under section 197.
The IRS ruled that step one and step two were a series of related transactions, and that the anti-churning rule of section 197(f)(9) would not prevent Buyer from amortizing its basis in the section 197 intangibles it was deemed to have purchased in step one of the acquisition of C. Further, the IRS ruled that Buyer could commence amortizing such intangibles on the first day of the month of the step one purchase.
Conclusion and Takeaways
In PLR 201820013, the IRS permitted the purchaser of goodwill to treat transactions that spanned more than a year as related transactions for purposes of testing relatedness to determine the applicability of the anti-churning rule. The taxpayer’s representation that the LLC Agreement established a binding commitment for the buyer to execute the step two purchase was a material representation. This is a reasonable approach to demonstrating that transactions constitute a series of related transactions for purposes of determining relatedness under the anti-churning rule. Thus, the binding commitment test can provide a method for taxpayers to find comfort when planning multi-step acquisitions of goodwill.
Additionally, the IRS permitted the purchaser of the goodwill to begin amortizing its basis in that goodwill immediately after such goodwill was acquired, rather than requiring the purchaser to wait until the end of the series of transactions. This is a helpful ruling for taxpayers undertaking multi-step acquisitions to provide certainty that they can begin amortizing their section 197 intangibles immediately after they are purchased rather than waiting until after the time for testing relatedness for purposes of the anti-churning rule.